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Geography, Trade, and Regional Disparities: The Case of the Missing Middle of Mexico

Story posted November 24, 2003

Contrary to what many economists believe, trade liberalization has not caused a more even distribution of wages in Mexico, but has instead caused workers in much of that nation's interior to suffer from declining wages compared to workers elsewhere, according to research by Stephen Meardon, visiting assistant professor of economics.

He shared his findings at a recent faculty seminar, and he began by offering reassurance to anyone alarmed by the title of his talk.

"The middle of Mexico is actually not missing — at least geographically," he said. "It's missing from the imagination of economists."

When economists consider the results of trade liberalization, they usually think in terms of what people do, not where they are.

"They don't think of the spatial dimension...they think of the industry dimension," he said. "Economists have been less successful in thinking about trade liberalization in terms of where people are and whether they'll be better off."

Meardon had a simple question that others weren't addressing: "How does location in Mexico determine one's fortunes after trade liberalization?"

To determine this, Meardon began by looking at the issue through the lens of municipal shares of manufacturing employment. In 1998, he saw what he'd expected — the federal districts in and around Mexico City dominated manufacturing, but there were pockets of manufacturing along the border as well.

"Trade liberalization for Mexico means basically trade liberalization with the United States," he said. Given that, growth in manufacturing would be expected along the border after NAFTA's introduction in 1994. And that's just what happened: From 1988 to 1998, for example, Tijuana exploded in terms of employment going from 2.15% to 3.76% of Mexico's manufacturing shares, and, though its shares of manufacturing remained high overall, there was a corresponding decline in greater Mexico City. But Meardon also noticed differences in manufacturing shares among the municipalities that were neither on the border nor in greater Mexico City.

"I'm struck by all the variation in the interior," Meardon said. "It doesn't seem to fit very neatly with the decline in Mexico City and growth at the border."

Because wages are increasing at the border, there's a "general consensus" among economists that the "regional wage contour is getting flatter," he said. In other words, there is less wage disparity throughout Mexico.

But just looking at the border and greater Mexico City leaves out a huge chunk of Mexico. Imagine judging the effects of a trade law on the United States by just looking at the effects in Washington D.C. and Texas. Throughout Mexico there are other sites of relative growth and decline.

"It makes me doubt this story about the flattening wage contour," Meardon said. "I'm just not sure I believe it." But despite his doubts, he admits that there is some theoretical support for the idea.

Krugman and Livas model, 1996

A theoretical model (Krugman and Livas, 1996) demonstrates what happens after trade liberalization. It plots a point in greater Mexico City (3) and another near the border (2), and it assumes the following:

Mobility of workers within a country

The existence of transportation costs for shipping goods.

Advantages to manufacturing in the same place as other companies because of economies of scale

Disadvantages to being in the same place as others because of commuting costs.

If there were no trade with the U.S., workers would want to live near the production center, so they would concentrate in area 3 and wages would be higher there. But after opening the border to free trade, workers would spread to region 2, causing wages to be more evenly distributed.

"You can see that employment shares in most of the middle of Mexico have not increased....In the words of the immortal Kevin Kline in A Fish Called Wanda 'What about the middle part?'"

Part of the problem with the model, is that it is based on state data, so it doesn't take into account the variations among cities. The lack of geographic information also means that the only variable that can be used to explain the differences in this model, is the distance from Mexico city.

"So what I want to do is find data that's more amenable to finding a contour. Not using state data, but using municipal data," Meardon said.

He set about building a new theoretical and empirical model to explain what was happening in the interior regions. The original contour model just used two points to plot its data — the border and Mexico City, but Meardon added a third — a municipality not in greater Mexico City and not on the border.

Meardon's model

In this model, people might want to spread from region 4 (Mexico City) to region 2 (the border), but what happens to region 3? If transportation costs are low, there could be a spread to that region as well.

"So what happens to region 3, in the middle of Mexico, depends," Meardon said, "and it depends on transportation costs." Because of this, the wage contour could be getting steeper or flatter, depending on what happens in region 3. Once he set up a model, Meardon used municipal data from 1988, 1993, and 1998 to compare it to reality.

He considered the distance of a city from Mexico City, as did those building the other wage contour, but because he included another point, he could also consider the effects of distance to the border, distance to the nearest highway, and distance to the nearest port.

"When I do that, because I include all these other variables, I'm able to come up with a wage contour that's much more reliable," he said.

To determine what was happening, he had to determine if the distance to Mexico City was becoming less important to a greater extent than the distance to the border was becoming more important, or vice versa.

If the border is more important to a lesser extent than the distance to Mexico City is becoming less important, there should be a thriving middle. But, if the border was becoming more important to a greater extent than the distance to Mexico City was becoming less important, there would be a stagnant middle.

"This is not just an academic exercise, this is of tremendous importance," Meardon said. Policy makers want to spread the benefits of trade, so understanding how trade has affected wages in different cities, and why, can guide policy.

Once Meardon had all this theoretically established, he tested it and found that Case B — the stagnant middle — was the reality (though it didn't hold true for 1988).

"This is, to my mind, a pretty startling reversal of the consensus in the wage contour," he said.

All other things being equal, most of the wages in the middle of the country are decreasing.

"Then again, all else is not equal," Meardon said. The municipalities are all different distances away from major ports and roads. "And that is important."

The importance of transportation is further demonstrated in Meardon's graph by the fact that the ridges that show increased manufacturing shares all occur along the highway.

"This says something important about what physical infrastructure that decreases transportation costs to municipalities can do," he said, "it shows how important transportation and highways are to wages."

Meardon's findings demonstrate the role of government, in terms of creating policy and investing in transportation infrastructure.

"It's not enough to let trade liberalization take care of it by itself," he said, "that's the lesson."

Meardon's findings are included in an Inter-American Development Bank book, Beyond Borders: The New Regionalism in Latin America, which is being distributed by Johns Hopkins University Press.